The government faces both ways on small business borrowing

By | Published: October 23, 2008

Today the government intends to give banking chiefs a strong tongue lashing on the need to lend more money to small business on sensible terms. This will be very popular with small business. It is all part of the government’s renewed spin offensive.

Readers of this site will know I hold no brief for bankers who lent far too much in the good times. I too am also critical of poor client service and failure to back decent businesses in tougher times where these occur.

The government, however, says one thing and does another. The banking regulator has recently demanded that banks keep much more capital relative to the amount of lending they do. The two most obvious ways for banks to comply are to lend less, and to generate more profit from existing customers to retain more cash and profit to bolster the banks’ reserves.

It should therefore come as no surprise to the government that this is exactly what banks are now doing. Just as the regulator recently demanded, banks are now seeking to reduce their loans to a range of customers. They are looking for all sorts of ways to generate more profit and cash. They will charge more and higher fees for arranging and renewing loans and they will increase the interest rate they charge borrowers relative to the interest rate set by the Bank of England.

If the government wanted to maintain or increase the amount of lending to small business, mortgage holders or any other favoured group, it should have told the regulator now is not a good time to demand bigger banking reserves and more banking capital relative to the volume of lending. If the government does want to continue with its programme of sharply reducing the excess credit in the system, as the Bank and the regulator have been trying to do since August 2007, it should honestly say so and admit this means a further squeeze on the mortgage and business loan customers of banks.

I had the impression from the actions of the authorities they are trying to take at least £100 billion out of the total credit advanced to businesses and individuals in the good times, as they clearly wish to reduce the credit bubble they allowed to build up. That is the type of figure implied by the change of banking capital ratios and the high interest rates selected by the Bank. Their problem is that such a large withdrawal of credit causes problems for many borrowers, and helps trigger a recession. The recession then places more financial pressures on people and companies, who need more borrowing to tide them over difficult times. That is why I recently wrote the piece saying we cannot afford the recession.

It is never easy deflating a credit bubble. You can try to do it quickly and dramatically. That means a rush of property repossessions and company bankruptcies, a collapse of asset values as those inflated assets are put through a fire sale, and then recovery from a much lower base. You can try and do it at a much slower pace, seeking to avoid a collapse of asset values. You need to administer your interest rates and regulatory requirements for the longer haul, keeping borrowing growth down but allowing sensibly priced maintenance or refinancing of what has already been lent.
The authorities need to make up their minds which they are trying to do, make it clear to the rest of us, and then set interest rates and capital requirements at an appropriate level for their decision.

Grandstanding at the expense of the banks they are seeking to buy large shareholdings in is no substitute for getting interest rates and regulatory requirements right for the outcome they desire in the real world. Pretending they are suddenly regulating a deregulated industry will not stand up to scrutiny. This has always been a highly regulated industry. It has also always had a form of price control dictated by government through the authorities choice of interest rates, the main price a bank imposes on customers. The argument is not about whether it should be regulated or not, but about why the regulation of money markets and banks went so wrong in recent years.

This entry was posted in Blog. Bookmark the permalink. Both comments and trackbacks are currently closed.

14 Comments

It would be possible to increase business lending while increasing recerves by reducing mortgage lending. I suspect if the banks are going from offering 125% mortgages at 7 times income to 90% at 3 times that is what is happening.

JR wrote:
> Today the government intends to give banking chiefs a strong tongue
> lashing on the need to lend more money to small business on sensible
> terms

What business is it of the Government what banks do?

We individually agree to permit the existance of State, so that it can perform tasks we individually cannot – defence, social security, etc.

Banks are privately owned entities. They belong to individuals. What they do is entirely and purely up to *them* and *no one else*. That's what freedom means. That is what liberty *is*. What on earth is the State, which we as a group of individuals created for specific functions, doing applying pressure to particular individuals to behave in particular ways? what about their freedom? what about their liberty?

If the State alleges this is being done for the "greater good", then we have created a monster, for we have now something which ignores individuals freedom by taking that which belongs to them and either spending it or handing it over to other individuals.

The "greater good" fundamentally and unavoidably involves the violation of private property rights.

In matters such as social security, we *agree* to contribute, because we see the need. But in matters such as how a bank lends money? at what point does what we clearly agree upon become that which we clearly do *not* agree upon? and then at what point is the State acting in its *own* interests or those of a minority – which is the point where the State is no longer something we have agreed to have exist; it has become a monster no longer in our control, oblivious to *our individual freedom*.

At this point I note the upcoming existance of identity cards, recent articles that the State wishes us to provide our passport when we buy a mobile phone, the monitoring of when and who we send emails and make telephone calls to, and the fact that we pay extremely large amounts of tax; 20% or 40% of income, 17.5% VAT, national insurance (employers being several times that of employees – something I discovered when contracting), and of course corporation tax, which raises the prices of all the goods and service we buy.

Economic freedom is just as important as personal freedom. It's no use being free if the State has most of your money.

I'd rather the BBC than the preposterous approach of Fox News in America. Their pro Bush stance on the economy is reaching ridiculous levels. I don't rate Obama on the economy either but to insist the economy is on the up despite the spate of bailouts, nationalisations and plummeting Wall Street shares seems daft to me. Wait till all that hits main street!

Yes thay are prepared to interview true mavericks like Ron Paul and Peter D Schiff, but the reception they get is terrible at times: Schiff is often shouted down (although he holds his own). Admittedly they are more respectful of Paul these days.

The closest to Fox News that we have in this country is Paxman. He has increasingly become a charicature of his old self. Quite why Heseletine didn't get up and thump him one last night when they were talking about the Osborne issue I dont know. Apparrently – accoridng to Paxman – George's error of judgement now is that he went on a rich man's yacht when others in the ocuntry are losing their jobs. Pardon me but wasn't Mandelson there? And I think Iain Dale said on his blog that Mr Brown has been on the same yacht at some point. And Rothy is a friend of Blair's. Pardon me (again) but have I just teleported into the middle of the Twilight Zone????? What is going on here????

The Government, the majority of the UK population and many, many UK companies are, using the British rather than the American terminology, – Over Geared.

We have been a nation of spenders as opposed to a nation of creators. The service industry has employed millions of UK citizens in the art of distribution and spending who in turn spend themselves. Was anything ever created?

Our manufacturing base has become smaller and smaller. Once logistic lorries in the UK carried raw materials but now they carry imported clothes and fast food.

Our two main earners for the nation, oil and global banking, are both in major retreat.

Has anyone noticed during any criticism of Banking Bonuses and High Earnings for taking large risks, how no one ever mentions the huge tax take that went into the government coffers at the time- 40% higher rate tax plus NI plus Corp Tax.

Soon FTSE shares will be dumped by many over geared hedge funds. For a moment you will say good bye to your pensions.

Soon Repossessions will be higher than the early 90's despite government rhetoric.

Soon middle class credit card spending will join the mass of unpaid secondary lending to the D's and E's.

Why?
The taxation system takes 43% of anything you earn. People who are successful (except those in government) are called names (Fat Cats) and hated. You cannot even go on their yachts!
Every effort you make is blocked by some eejit with a clipboard and a sheaf of regulations.
The dear old Comprehensive system provides more eejits with rights, but they cannot either read or write! And it pays them to lie in bed.
The days when Watt marvelled at the kettle and went out to build a steam engine have long gone.
And then there's the EU…….

Oh dear, more 19th century thinking, let's build cars blah, blah. No matter how much the government 'help' manufacturing it's never going to be enough to compete with Chinese or Indian workers, thus we should not waste taxpayer money in trying. Instead culling unnecessary government jobs and regulations (more or less all of it, let's be honest) become a genuine low-tax economy* to attract industry and commerce and while we are at it, we could make the UK a tad more civilised by jailing people for much longer tarriffs (No, Jackie Smith, if people are caught with knives they need rather more than to be "brought before a court" and no doubt scolded before being released to sign on, procreate, buy Donitz's plasma TV's and then stab someone). Cut taxes and enforce laws and we can again become the 'Dubai' of Europe attracting companies and successful people, but continue down the road we are on, and national bankruptcy beckons in an anarchic chaos of violent crime.

*If public spending had only grown in line with inflation since 1997, we could have abolished income tax, corporation tax, capital gains tax and inheritance tax, leaving the taxpayer £200 billion better off. Source ASI http://www.adamsmith.org/tax-freedom-day/

Cheap money got us into these difficulties. A doubling of the money supply in just 5 years (based on M4) without the corresponding doubling of economic growth. That money had to go somewhere and there is very little evidence that there were offsetting movements on the demand side (for money).

Bankers played their role in this by developing dodgy financial packages – e.g. asset backed securities as a means of minimising risk. But that was a product of the excessively low interest rates which inturn fuelled the demand and supply for such products. What banks will put together loan products that emphasise prudence and caution when their competitors are providing cheaper souces of funds? Likewise adverse incentives for borrowers.

The market can work to our benefit if the right institutional arrangements are in place. And that doesn't mean excessive regualtion and state ownership. Rather a sound monetary policy that does not treat interest rates as the principle means of electoral bribery and which isn't narrowly focused on inappropriate targets (e.g., CPI) to the exclusion of more pertinent ones (e.g., asset prices).

I now see a Labour govt that is in its element. The "big excuse" they have yearned for has finally come: justification for the reversal of the pro-market reforms of the Thatcher era and advance beyond that aswell. The unrestrained glee on the faces of Labour MP's as they cheer Brown's nationalalisation plans to the rafters is evidence of that. The bullying of the banks is yet another step in that direction. Hayek's road to serfdom is quickly becoming a quick walk down a country lane. No thanks.

Suggest you take a look at the FT's Alphaville which reports on a blog called "Infectious Greed" which reports from Bloomberg which believes that most US and UK banks will end up owned by the state.

The reason? Never mind the securitised debt, it's all the home and commercial loans waiting in the wings and maturing to a stonking rancid state as we head into negative growth which the banks are going to find overwhelming.

On the matter of banking lending to small and medium sized businesses there are two issues that will preclude any satisfactory solution to the problems of high interest rates and reducing loan levels for these. The first is that many such facilities are covered by personal guarantees, which usually means the family home. The family home however is a depreciating asset today and is likely to continue to be so for some time. Therefore the 'gearing' of the business becomes less attractive meaning that less and not more support can be justified. The second factor is that of judgement, or rather lack of it. Until the 1980s the business bank manager knew a great deal about his cutomers and their trade and was able to exercise discretion based upon this knowledge. Now however this function is largely carried out elsewhere in the bank, using systems that take little account of whether or not a particular company is likely to come through a bad time if their support were to be forthcoming. What Gordon Brown should be preaching at the moment therefore is for a return to a sound banking culture of the past but as he has never been exposed to business in his working life, this is unlikely to happen.

At the moment, the Labour Party are limiting themselves to pious statements about naughty bankers being nice and kind at all times to poor people. Meanwhile Northern Rock has just about doubled its repossessions. How long this tension can continue is anyone's guess. I am waiting, myself, for the sacred single Mum with her bairn being ejected into the snow. Picture, natch, on the front page of every newspaper.
As to the decision whether or not to clean up the debts quickly or more slowly, the government must, surely, opt for the long term?
Otherwise, how will they win the next election?
AND there will be no long term if their debts stand at £2 trillion – and rising. (Including all those pensions and PFIs and Bank failures).

I was with you until the "get married" bit. If you'd have said go to Hawaii with various offspring and latest transient 'boyfriend' funded by some benefit or other ~ fine, but married? ~ it just pushed the boundaries too far. Although, the way Sterling is heading South, maybe the Sovereigns will turn out to be unconscious smart investments.

About John Redwood

John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.